Who Wants Industrial Policy?

Dani Rodrik of HKS is one - with some twist from the old definition.

Nonetheless he said:

The standard rap against industrial policy is that governments cannot pick winners. Of course they can’t, but that is largely irrelevant. What determines success in industrial policy is not the ability to pick winners, but the capacity to let the losers go – a much less demanding requirement.

Uhm, I am not convinced. Letting the losers go is very hard, and probably equally demanding with picking winners. I made a serving in this Cafe sometime ago, arguing that old policies don't simply die.

(Film) Industrial Policy, the UK Way

So the Hollywood dominates the world film market. British film is declining. What should Britons do? The standard economics would be letting the competition goes on. Let lousy films with funny accent perish, if they can't cope with the market force.

Probably the Britons can no longer stand losing their cultural supremacy against their ex-colony. As Prime Minister Hugh Grant¹ once said:

We may be a small country but we're a great one, too. The country of Shakespeare, Churchill, the Beatles, Sean Connery, Harry Potter. David Beckham's right foot. David Beckham's left foot, come to that.

And his Chancellor of the Exchequer (a.k.a: Minister of Finance in case you are not familiar with this term) Gordon Brown --no, he's the real Tony Blair's Chancellor—announced in September, 2004:

I shall hereby declare that small budget films entitled tax relief 20 percent of production cost, and 16 percent for films costing more than £20m.²

And the result, as claimed by UK Film Council, is --for the money spent for film-making:

Statistics from the UK Film Council reveal that £840m was spent last year, up by 48% from the £569m spent in 2005. Studios are also coming to Britain in greater numbers - inward investment increased by 83% to £570m.³

Yeah, right. So much for the free market idea.

Now move to Indonesia. We want to have strong film industry, producing not only money-making but also good quality films. The ala UK tax break proposal seems attractive. But how can we be sure that taxpayers money going to the film makers, instead of building the schools or rice subsidy to the poor, would produce the industry boom like in UK –and, I would like to add, not the likes of crappy local films we often find in cinema nowadays? If we insist for the plan, we’d be better sure that, first, the economic benefit (multiplier effect on income and employment) coming from the plan exceeds the cost for tax break (or subsidy). Second, the produced films are competitive vis-à-vis Hollywood ones, which usually come from the quality of the product. And third, the mechanism to prevent discrimination in selecting the recipient is in place and well enforced.

A tall order indeed.

---
¹ In Love Actually.
² Well, not precisely, but see official guidance for UK film makers on tax-relief.
³ From The Guardian

film | industrial policy

Industrial Policy: Kicking and Screaming

Folks, sorry for disappearing for almost 2 months.
Allow me to share thoughts from my activities at workplace.

What is industrial policy? Well, there are many definitions but the most generic might be determination from the state (government) to favor and develop some economic activities than others. In particular, determination from the state to develop local entrepreneurs over facilitating foreign businesses.

It was like a déjà vu when I recently listen to a talk on industrial policy. There I was, just like the old days in Salemba, listening to a lecture on a topic that I thought was already dead. Instantly I recalled sitting in a class listening to talks (Faisal Basri and Dorodjatun) about the danger of protecting industries. An infant industry, as we used to say, is nothing less than a parasite, breeding corruption, fattening bureaucrats, and screaming for protection to achieve anything but ability to manufacture efficiently.

The speaker, Robert Wade of LSE, tried to make a case that industrial policy is increasingly relevant in an open economy. He then mentioned several approaches that at first sound innovative such as what he called “nudging” and “preferential treatment”. Example from the first is officials willingness to share information with domestic private firms on foreign incumbent cost structure, technological capability etc. Example from the second is rather blunt: officials imposing higher taxes over imported intermediate goods that would otherwise supplied by local suppliers.

But why now ?? Why is this still relevant now, 9 years after financial havoc ransacked Jakarta’s banking house of fraternity? Why talk about this after Chandra Asri (crony “foreign” chemical manufacturer), Bakrie (yeah.. hmm..), and IPTN (state aircraft industry) stumbled following years of sweetheart-oh yeah baby relationship with the state?

Moreover, I don't think Prof. Wade's example indicate new practices in institutionalizing industrial policy. Popular anecdotes from success stories are often used to highlight the importance of industrial policy (IP). Professor Wade mentioned a case from Taiwan glass and semi-conductor. His story suggests that there was a deep intervention of government officials in sharing and packaging strategic information about market potentials. Officials in Taiwan were also active in persuading foreign firms to switch to local suppliers. Other people mentioned about case studies from Korea shipping industry. There stories suggest even deeper relationship between the state and Chaebols (conglomerates). At some point, Korean government mandated that all oil import to Korea must be carried using Korean made vessels. Even Indian software industries are not immune. Some stories suggested that Bangalore was the location of many military labs with highly talented engineers. Finally China. They succeeded in putting few men around the earth orbital, period.

In short, fragmented stories hint that state signature is present behind the success of any country’s industrial development.

Indeed, Prof. Wade is not alone. Some have been die-hard believers of this concept, like Alice Amsden of MIT – although she uses anecdotes to make the case. Some have revived this idea and provide it with a high-powered shot of empirical evidence – like what Ricardo Hausmann, Jason Hwang, and Dani Rodrik have done. Oh, not to mention also some politicians and half-baked economists who are mixing self interest with bad economic policies. But from Hausmann, Hwang, and Rodrik, this is what they said:

" When local cost discovery generates knowledge spillovers, specialization patterns become partly indeterminate and the mix of goods that a country produces may have important implications for economic growth. We demonstrate this proposition formally and adduce some empirical sup- port for it. We construct an index of the "income level of a country's exports, document its properties, and show that it predicts subsequent economic growth" [ What You Export MattersRicardo Hausmann, Jason Hwang, and Dani Rodrik NBER Working Paper No. 11905]

Their paper clearly indicates that a country must think seriously on what product to make and to export. If I can be more blunt, they resonate the argument that low wages, banana harvesting, and t-shirt/sandal making do not get you that far. One needs to master the capability to manufacture with sophisticated technology if productivity is expected to take the economy to a higher level. In away, it sounds like idea of BJ Habibie, supposedly one of Indonesian brightest person.

At this stage, I personally agree. I think under general circumstances, relying on primary commodities will not take you off.

But somehow I still can not conceive that the ultimate recipe for success is to have the state meddling with affairs of private enterprises in developing path to success. My reasons are the following:
(1) Boring reason: Political economy. Many cases suggest that private sector could not wait to influence regulation by working with the state. Once they did, they do not have incentive to stay straight.

(2) Have boring reason some more: Costs of protection are usually too high and often resulted in inefficiency. Protection distorts price signals which enable firms to correctly internalize their costs. Say you again you give our cement factory, Semen Padang (SP), a subsidy. We can bet that SP have the chance to perform worse than before because their cost is artificially low. With proper corporate governance, low cost may not translate to higher productivity because some of the idle cash flow to local festivities – with local MPs.

(3) Ah.. am I clever or what: Information problem. Some cases show that those who succeeded in developing product for export are indeed good firms. The problem is that the government can only see if those firms have already done their export. Thus helping exporters in this case may not be efficient because those firms already have high likelihood in succeeding without the help from the state. Using Indonesian manufacturing data, I and Beata Javorcik did an empirical exercise where we found that growth in total factor productivity among firms is the highest during period about to become exporters. Once succeed in exporting, their productivity started to level off. State can only see productivity after they succeeded.

(4) Only wise (insane) person can say this: One difference between South Korea in the early 80s and Indonesia in early 90’s was luck i.e., God's willing. Indonesia had the ingredients to become S.Korea: strong government, strong military presence in all social and political aspects, liberalized capital markets, protecting its conglomerates, amazing economic growth despite weak institutions. South Korea built ships, we did airplanes. South Korea built cars, so did we. They made electronics,.. (who is making electronics in Indonesia?). South Korea had border skirmishes with N. Korea, we even went further to invade East Timor. But what missing was that Indonesia did not have a leader with highly discipline sons/daughter. Leaders were smart and honorable men, yet somehow their characteristics are absence in their family members (specially sons/daughters). Family members were recklessly fell in love with private sectors hungry for protection and generals hungry for cash.

Having said two boring, one bright, and one insane reason, what should a country do?
(1) Develop necessary infrastructure for entrepreneurship to flourish. Investment in public education and telecom are mandatory. A private consultant mentioned that Indian software industry took off after government enabled them to uplink their work via satellite and connect to the US. Rather than creating another state company, just figure out regulation to let private firms compete in providing their services.

(2) Develop necessary financial market that generates financial instruments for entrepreneurs to hedge their risks. Institute a credit rating agency that can identify lending risk based on pattern of lending repayment, not on after they defaulted or have been visited by the police. Induce private financiers to develop local skills and introduce sophisticated product for local entrepreneurs. Subsidized credit is not the answer. But regulation in allocating x% of loans to local entrepreneur can force banks, including foreign banks, to develop such knowledge.

(3) Identify market failures that impede innovative ideas to grow. R & D is expensive, but not for imitator. Work on law and institution in preserving intellectual property.

(4) Do a PR campaign. If fast food can appear healthy, why can’t the state appears that they are supporting local entrepreneurs?

While those suggestions indeed sound like a laundry list, but at least, I think they are good ideas.
Industrial policy Exporting Development policy

The Industrial Revolution: why did it happen in Britain?

Continuing my piece on the Industrial Revolution, (by the way, I visited the legacy of the Industrial Revolution in Lowell, MA last month) Clark’s made a valid point in championing the endogenous growth theory as the best-so-far explanation for the Industrial Revolution. His analysis was parallel to what David Landes (1999) argued about the nature of human civilization in Europe at that period that paved the way to the Industrial Revolution. Landes emphasized three factors that characterized the human progress at that time: 1) the growing autonomy of intellectual inquiry, 2) the development of common method of invention, and 3) the routinization of research and diffusion.

These three considerations what made the distinction between Europe and the Islamic or Chinese world. The other civilizations have produced some progress (for example, gun powder was invented by the Chinese, and the concept of 'zero' was invented by the Arab). Nevertheless, they failed to make the progress continued and uninterrupted.

However, Clark’s analysis did not really touch one important question: why did it happen in England, and not somewhere else in Europe, if not in the other part of the world? In fact, as Landes mentioned, in 14th century Italy there has already a technology of processing silk that flourish the Italian silk industry. This industry has many things in common with the English cotton mills some four centuries later, in terms of technology and factory-like system of production. So why then the Industrial Revolution had to wait, and why when it happened finally, it happened in England?

Landes gave two answers. First, it was a matter of supply and demand. Silk was a luxurious product, costly to make so the price was high. Only the elite segment of the society could absorb the supply. Meanwhile, the cotton-based textile produced in England was met with the demand for the product. Second, England has already had the advantage of being a nation. It was not only a “state or political entity, but a self-conscious, self-aware unit characterized by common identity and loyalty and by equality of civil status.”

If these explanations have to be true, then it may explain why it was not Italy or Germany. But why it was not Spain or Portugal? Is cultural explanation significant, and if it is, how do we put it into the framework of endogenous theory?

The endogenous growth theory, although it is more superior to the other two theories as Clark has shown, still raises more new questions.

The Industrial Revolution: why did it happen?

Just finished my essay on British Industrial Revlolution. I made an assessment of a paper from Gregory Clark (2003). Clark’s paper sought to explain why there was a very long period in the human civilization history before the Industrial Revolution brought a sustained growth of the world economy – at least for a group of countries – in 1820. The Industrial Revolution and the ‘great divergence’ that followed it could not be explained by massive growth of capital accumulation, both physical and human capital. As he argued, “physical capital accumulation explains only a third of the growth of income per person over time, and about one third of the differences in income per person across countries,” while adding human capital accumulation “only explained another 0.18% of the growth.”

The Industrial Revolution, then, was characterized by the ‘unexplained’ part of the standard growth accounting. This unexplained part is often referred to as Total Factor Productivity (TFP) or technological progress. After about two millennium of low growth technological progress, the world economy marked a jump in the growth of technological progress, from 0.1 to 0.77 percent per year in just a century. Clark called this phenomenon as a growth driven by “knowledge capital.” This knowledge capital alone explained 50-70 percent of growth of income per person.

Why then, there was a sharp increase in growth of knowledge that led to the Industrial Revolution? Clark presented three theories that could explain this: the exogenous growth theory, multiple equilibrium theory, and endogenous growth theory According to the exogenous growth theory, some changes outside of the economy, notably institutional change, were the driver for this growth. These changes would include “changes in the institutions governing the appropriability of knowledge, or the security of all property.” Among the sources of this exogenous growth theory, Clark mentioned the arrival of constitutional monarchy in England in 1689 (North and Weingast 1989) or the Enlightenment movement in 18th century Europe (Mokyr 2003).

Clark disagreed with the exogenous growth theory for at least two reasons. First, still it did not explain why such an institutional change should wait until 1820. Even if it was the constitutional monarchy regime switch and enlightenment movement that drove the changes, the Industrial Revolution should have taken place two hundred years earlier. Second, the data of number of patents did not suggest that the Industrial Revolution economy has provided good protection and reward for innovation.

A second theory is the multiple equilibrium theory. The proponent of this theory, most notably Gary Becker and Robert Lucas, argued that the world economy before Industrial Revolution was in a stagnant, ‘bad’ equilibrium characterized by the Malthusian trap. Only a shock would move the economy from this ‘bad’ to a ‘good equilibrium’ that provided driver for growth. Becker and Lucas argued that the shock was something that created incentives for family to invest in human capital; a signal “in the form of higher relative earnings for educated children.”

Clark again disputes the validity of this theory. He argued that “no evidence of any market signal to parents as we approach 1800 that they need to invest more in the education or training of their children.” Moreover, there was also no evidence that average family size was declining prior to 1800, something that should have verified Becker’s ‘less children, more quality’ argument.

The third theory, the endogenous growth theory, is his champion. According to this theory, the source of growth that led to the Industrial Revolution was within the economy. This internal feature “evolved over time in the long pre-industrial era to eventually create the pre-conditions form modern economic growth.” The internal feature is ‘ideas.’ According to Michael Kremer (1993), “there was substantial but slow productivity growth in the world economy in the years before 1800, and that all got translated into a huge expansion of the world population. That larger population produces more ideas and more rapid growth.”

Clark supported this theory for the reason that it is consistent with the empirical findings that: a) the productivity and technological change growth was positively correlated with growth of population over time, and b) the rate of technological advance is also positively correlated with the size of land area, sin the bigger the land area, the higher is the potential population. He even concluded that not only this endogenous growth theory help explaining how the Industrial Revolution took place, but also why it took place at a certain time in the history. And, finally, this theory led to the conclusion that Industrial Revolution is inevitable.